In a jolt to those investing a larger amount of corpus to the Employee's Provident Fund (EPF) and Voluntary Provident Fund (VPF), the Budget 2021 has made interest income taxable. With this, EPF contribution no longer enjoys the Exempt-Exempt-Exempt (EEE) status, albeit for high income employees.
"As per the provisions of the Finance Bill, from April 1, 2021 onwards, the interest on any contribution above Rs 2.5 lakh by an employee to a recognised provident fund is taxable. That is, if the total employee PF contribution (mandatory + voluntary) contribution is more than 2.5 lakh, the interest earned on the excess amount will be taxable as per slab," says Rachit Chawla, CEO & Founder, Finway FSC.
This is in line with the Budget announcement made last year in which employer contribution was capped at Rs 7.5 lakh for the Provident Fund, Superannuation Fund and National Pension Scheme.
"Last year, the government covered the employer contributions to retirals under the tax net whereby employer contribution exceeding aggregate of Rs 750,000 to the Provident Fund, Superannuation Fund and National Pension Scheme and interest accrued on the same was included in the taxable income in the year of contribution itself. This will act as a deterrent for individuals, especially high net worth individual, who have been contributing higher amounts as their share of contribution to PF, primarily with the purpose of earning higher interest. The computation mechanism in this respect is to be notified by the authorities," says Divya Baweja, Partner, Deloitte India.
Why has the government done it?
The interest rate on EPF is typically higher than other small savings schemes and fixed deposits that offer guaranteed returns. It was fixed at 8.5 per cent for the financial year 2019-20, while small savings schemes such as public provident fund, senior citizen savings scheme, Kisan Vikas Patra, and Sukanya Samriddhi Account are earning 7.1 per cent, 7.4 per cent, 6.9 per cent and 7.6 per cent, respectively.
The higher interest rate on EPF prompts employees to put higher corpus in EPF, which in turn makes it difficult for the government to pay interest on the same.
"As paying tax free interest on PF becomes more and more unsustainable, the government wants to curb high income earners from self-contributing more to their PF accounts. Interest accumulation in employee PF in excess of Rs 2.5L annually to now be taxed, however, method of calculation will be specified later. A large tax-free interest accrual which is not taxed on withdrawal either, is now being rationalised and will mostly impact the high-income bracket," says Archit Gupta, Founder & CEO, ClearTax.
As per the government, the move has been taken to rationalise the tax-free income on provident funds. "Instances have come to the notice where some employees are contributing huge amounts to these funds and entire interest accrued/received on such contributions is exempt from tax under clause (11) and clause (12) of section 10 of the Act," says the Finance Bill 2021.